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Risk Managers

The responsibilities of risk managers span the entire structured product value chain. They potentially include the following tasks: implementing a rigorous new product process, verifying pricing models, ensuring that derivatives risk is accurately communicated to customers, monitoring portfolio valuation and P&L, calculating value at risk and potential credit exposures, and auditing operational management and customer service.

Structured products present specific risk management challenges:

The new product process remains labor-intensive as existing modeling environments do not always facilitate pricing code reuse and often require new valuation code to be written even for minor product variations.
An inadequate representation of financial products can make model vetting cumbersome. Over the past decade, many institutions have developed payoff languages that define the meaning of a contract in the context of pricing. Payoff languages offer limited flexibility to accommodate changes in models and numerical implementations for a given contract definition. In addition, pricing model implementers must deal with market conventions and business rules instead of focusing exclusively on the mathematics of valuation.
Marketing documents should provide a complete picture of the risks inherent in a complex product. Without a proper analytical infrastructure, the production of such documents is a time-consuming, error-prone, and costly process. Banks that do not systematically deliver a complete risk assessment of customer offerings are exposed to a legal risk of misrepresentation.
The evolving structure of a contract, as it progresses in its life cycle, is challenging to represent. A clear framework for describing and valuing complex products as they progress in time is required to periodically revalue portfolios, to simulate the value of a contract over a set of future dates, and to calculate value at risk and potential credit exposures.
The maintenance of structured products is rarely automated. Complex contracts are invariably redefined in several systems and/or processed manually. Multiple contract representations are an important source of operational risk.
Many institutions have chosen to move trade data stored in production systems to a centralized data warehouse for the purpose of calculating consolidated risk measures. Data warehouses based on an entity-relationship data model cannot exhaustively describe the semantics of structured products.

In summary, inadequate systems for designing and managing structured products expose banks to financial risks and, perhaps more importantly, to the reputation risk stemming from potential failures in customer-facing and operational processes.

After LexiFi

Key Features

Precise and Exhaustive Product Definitions. LexiFi enables users to precisely and exhaustively describe sophisticated financial products, based on any type and combination of underlyings, using a limited set of core constructs.
Monte Carlo and PDE Pricing Code Generation. Contracts are valued with the appropriate financial model and discrete numerical method—typically Monte Carlo or PDE. LexiFi automates the specification of how a contract's definition should drive the sequence of numerical calculation steps. For each contract, LexiFi generates specialized pricing code that is then compiled and run natively to perform the valuation.
Pre-Packaged Analytics and Valuation Libraries. LexiFi comprises tools to prepare in-depth case studies for new products, including:
- an application that simulates the execution of a contract through time for a given historical or forward-looking scenario, records the cash flows derived from the contract along the simulated path, and calculates summary performance metrics such as an annual return;
- an application that simulates the evolution of a contract's value over a set of future dates: LexiFi simulates the evolution of the contract as life cycle events unfold, records cash flows that occur between today and each future valuation date, and calculates the value of the residual contract;
- a contract explorer that enables users to exhaustively analyze all potential contract execution paths;
- a large collection of Monte Carlo and PDE implementations of industry-standard interest rate and equity models.
Marketing Documents. Users may rapidly assemble informative and consistent marketing documents and term sheets that consolidate contract definition, simulation, pricing, and event planning information. All analyses are based on a single product specification. LexiFi ensures that the consistency among all input and output elements is maintained. The production of marketing documents may be scheduled and automated.
Formal Operational Model. LexiFi systematically detects and processes all events in a portfolio of complex products and performs the required simplifications as a contract progresses in its life cycle.
Contract Life Cycle and Pricing Synchronization. LexiFi guarantees that pricing code always mirrors the state of each contract. The combination of a formal operational model and pricing capabilities provides a unified framework for valuing complex products as they evolve in their life cycle, for simulating the value of a contract over a set of future dates, and for calculating value at risk and potential credit exposures on a portfolio of exotic products.

Benefits

LexiFi quantifies the risks of structured products, creates a controlled environment for managing complex derivatives, and, ultimately, helps to protect the reputation of the institution.

Automate the New Product Process. LexiFi users develop libraries of increasingly higher-level product assembly components that accelerate the definition of new structures. MLFi's exact product specifications improve communication between parties and lend themselves to automated processing of various sorts, including pricing, simulation, and event management. In addition, LexiFi's SQL database integration capabilities facilitate the immediate automation of operational management and reporting for new products, regardless of their complexity. LexiFi provides all the tools needed to commodify new products quickly.
Implement Robust Model Vetting Strategies through Method and Code Redundancy. LexiFi's ability to value the same contract with different models enables a number of model verification strategies:
- Comparison of Closed Forms and Numerical Methods. When a contract admits a closed form for a given model, users may easily confront numerical and closed form results.
- Comparison of Financial Models. Users may also compare implementations of different financial models.
- Implementation in Several Programming Languages. Model errors may be minimized by implementing the same model and the same numerical method in different programming languages. LexiFi delivers a collection of models implemented both in MLFi and in C.
- Choice of Scientific Library. LexiFi is interfaced with a number of proven scientific libraries. Users may switch scientific library by modifying a single parameter in many of LexiFi's model implementations. This provides an additional means of validating valuation algorithms.
Limit Legal Exposure on Derivatives Sales. LexiFi helps sales professionals to provide a balanced picture of the risks and potential financial consequences for the customer of accepting the terms of the proposed transaction. Fact-based sales practices reduce the risk of misrepresentation.
Execute Structured Products Flawlessly. LexiFi reduces operational risk across the structured product value chain: the system automates product development, sales, operational management, and customer service through a safe, integrated, and transparent process.
Monitor the Value and P&L of Complex Derivatives. The combination of LexiFi's formal operational model and valuation capabilities enables the ongoing valuation of complex portfolios. LexiFi provides tool to precisely analyze residual contracts and the history of past events and cash flows. Daily revaluation reports may explicitly include the reference of the official set of market data and pricing model parameters on which the calculation is based.
Calculate Value-at-Risk and Potential Credit Exposure Estimates that Accurately Reflect the Evolving Structure of Complex Products. LexiFi users can define scenarios that describe the joint evolution of market data and pricing model parameters. LexiFi accurately represents residual contracts on each future valuation date, taking into account path-dependent events—e.g., fixings, barrier crossings, intermediate cash flows—occurring between today's date and the future valuation date.
Establish a Conformed Standard for Communicating between Systems, People, and Counterparties. MLFi may serve as a pivot format that preserves the meaning and integrity of contracts during their entire life cycle. MLFi's reliance on elementary combinators for defining financial contracts enables the development of an infrastructure devoid of product restrictions.
Accurately Represent Structured Products in Your Data Warehouse. LexiFi obviates the need for a complex data warehouse schema. LexiFi provides a simple, schema-independent way of persisting MLFi contract definitions in a SQL database: contracts and their lifecycle history are represented in a binary object that may be stored in a single table column. MLFi's contract descriptions encapsulate the most complex definitions: the central data warehouse schema only needs to describe the static data elements that are linked to MLFi contract definitions. LexiFi's contract manipulation capabilities are exposed as stored procedures, which enable users to query any contract or portfolio using standard SQL syntax.